The Chicago Plan Revisited

|Peter Boettke|

That is the title of a new working paper from the IMF. I would be very interested in hearing the opinions of Steve Horwitz, Larry White, George Selgin, Gearld O'Driscoll and Richard Ebeling on this discussion of the reconsideration of the Chicago Plan as an answer to financial instability.

Just the other day I was speaking with David Levy about Leland Yeager's In Search of a Monetary Constitution, and in particular Murray Rothbard's contribution to that volume. One must realize that Rothbard's positon is not out of step in the least withn that context. Rothbard is, as we all know, an advocate of a full-reserve system. But that is not as unusual as one might first think. Irving Fisher, Henry Simons, and Milton Friedman all wrote defenses of full-reserve banking.

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I'll address the issue rather than the paper.

I do think it is very interesting, however, that the IMF is reconsidering the Chicago Plan. The obvious companion paper would be on free banking. Dare we hope?

There is a lot of interest in monetary reform. Pete mentions Yeager's In Search of a Monetary Constitution. Earlier this year, Liberty Fund held a 50th anniversary reconsideration of that volume.

Rothbard's argument for 100% reserves is different than that of the Chicago Plan. He makes a moral argument for the system. Advocates of the Chicago Plan make an economic case for it.

The basic criticism of the Chicao Plan is that financial markets would innovate around it by inventing new products substituting for 100% reserve-backed media. Henry Simons reconized this and suggested baning all forms of short-term credit.

Subsequent financial history supports the doubts over the Chicago Plan. As Barkley Rosser recently noted here, the housing boom was largely financed by the so-called shadow banking system. There was huge growth of money substitutes, which was reflected in movements in the velocity of conventional monetary aggregates.

The Chicago Plan seeks to control just the kind of financial instability we've recently witnessed. Would it have prevented it?

My thoughts concerning the Chicago Plan are here. The main thing that the new study doesn't show is any appreciation of the regulatory roots of the "instabilty" that such plans were originally meant to correct.

Milton, as usual, did appreciate this.

If I have time I will try to offer some more specific remarks concerning the new study.

Pete, you call it "full-reserve banking." But a money warehouse is not a bank -- it makes no loans. And for a warehouse, the property held in the vault is not really a "reserve" but a bailment. The bailed property is either there or not; it isn't a matter of degree, partial or full. To summarize: "full-reserve banking" is neither full, nor reserved, nor banking.

Jerry O Driscoll: "Rothbard's argument for 100% reserves is different than that of the Chicago Plan. He makes a moral argument for the system. Advocates of the Chicago Plan make an economic case for it."

Incorrect. Rothbard makes both economic and moral argument. Just his economic argument is different (and better) than theirs. And, what about Mises? He makes an economic argument identical to Rothbard's, without ever mentioning the ethical problem. As for Rothbard, just one example, after 60 seconds of googling will suffice:

"Another argument holds that the fact that notes and deposits are redeemable on demand is only a kind of accident; that these are merely credit transactions. The depositors or noteholders are simply lending money to the banks, which in turn act as their agents to channel the money to business firms. And why repress productive
credit? Mises has shown, however, the crucial difference between a credit transaction and a claim transaction; credit always involves the purchase of a future good by the creditor in exchange for a present good (money). The creditor gives up a present good in exchange for an IOU for a good coming to him in the future. But a claim-and bank notes or deposits are claims to money-does not involve the creditor's relinquishing any of the present good. On the contrary, the noteholder or deposit-holder still retains his money (the present good) because he has a claim to it, a warehouse receipt, which he can redeem at any time he desires. This is the nub of the problem, and this is why fractional reserve banking creates new money while other credit agencies do not-for warehouse receipts or claims to money function on the market as equivalent to standard money itself."

The Case for 100% Gold Dollar, second edition, pp.45-46).

Sounds pretty much like an economic argument to me. And of course, as anyone who had ever read Rothbard knows, there are many similar places in his works.

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On the subject of instabilities in fractional reserve, George Selgin refers above to an article penned by himself. However that article seems to deal with instabilities resulting from changes in the public’s desire to hold dollar bills and/or different types of dollar bill (private bank issued versus Fed issued).

That is hardly the issue in 2012. The main source of instability nowadays (which was always there even centuries ago, as Walter Bagehot explained) is plain old asset price bubbles. E.g. houses rise in value, which makes them better collateral, so people borrow more on the basis of that collateral, etc etc . Fractional reserve assists that process because private banks can lend money into existence to boost the bubble. There is a chart here showing the rapid expansion in the four years prior to the crunch in Britain of private bank money relative to the monetary base (scroll half way down):

Re Lawrence White’s comment above, he seems to think that full reserve consists simply of “warehousing” money and not lending it on. If that is indeed all that full reserve banking consisted of, the he is right to say it’s not banking.

However, full reserve, at least as advocated by Laurence Kotlikoff in the U.S. and Prof. Richard Werner in Britain consists of requiring depositors to make a choice, as follows. First, they can have their money kept in a 100% safe manner: it is simply warehoused and it gets taxpayer backing, plus the money is instant access. Second, they can opt to have their money loaned on or invested. But in that case they carry the loss if the underlying loans or investments go bad, plus there is no instant access. That way, banks cannot create money. Plus it’s near impossible for a bank to fail, thus there is little by way of taxpayer subsidy of the banking system.